5/03/2001 @ 8:46AM

Stock Focus: Overvalued Technology Companies

Though a noted bear,
Paul
McEntire
Paul McEntire
takes a subdued tone when it comes to the question of whether the market is overvalued. The chairman of
Skye Hedge Fund
, a $5 million (assets) fund with long and short positions, McEntire concedes that many companies are now good long-term investments, particularly large technology companies with proven business models.

But McEntire, who holds a Ph.D. from Stanford University’s engineering and economic systems department, is less charitable when it comes to companies with speculative business models, especially those carrying a large debt load. One example:
Exodus Communications
, a provider of Internet hosting services. In its latest fiscal quarter, Exodus reported a loss of $650 million on sales of $349 million.

Exodus carries a whopping $2.8 billion in long-term debt. “If you’ve got over $2 billion in debt, you have $250 million to $300 million in debt service to overcome before you can become profitable,” says McEntire.

The market hasn’t been oblivious to Exodus’ financial situation–even after a recent rally, the firm’s stock is off 84% from its 52-week high.

Our table lists ten stocks that are overvalued by at least one metric. Despite having market values more than $1 billion, all but one have estimated price-to-earnings multiples in excess of 100. The exception, Exodus, has a negative P/E. Though depressed, many of these stocks have made dramatic upside moves since hitting lows earlier in the year.

Another measure of overvaluation: the price-to-earnings growth (PEG) ratio, which divides the estimated P/E by the median long-term earnings growth forecast. The general rule of thumb says a stock is undervalued if its PEG falls below 1, but is overvalued if its PEG is greater than 1. Based on 2001 projected profits, the companies in our table have PEGs of 2 or higher. Using 2002 estimates, all PEGs remain well above 1.

True to its name,
Extreme Networks
sports a 2001 PEG ratio greater than 10. Extreme builds network infrastructure products, primarily switches. Since setting a 52-week low of $12 in early April, the company’s shares have enjoyed a 203% bounce and trade at well more than 200 times estimated profits for this year and next.

The stocks in our table are also expensive when measured by their price-to-sales ratio (PSR). This ratio varies widely from industry to industry; McEntire suggests being wary of companies with PSRs higher than their peers.

Perhaps the most striking PSR in our table comes from Piscataway, N.J.-based
Enzon
. The biopharmaceutical concern, which boasts partnerships with drug giants such as Aventis
and Schering-Plough
, had $22 million in sales in its latest 12 months, giving the company a PSR of 115. By contrast, Pfizer
and Schering-Plough carry PSRs of 9 and 6, respectively.

Enzon’s drug pipeline includes several potential cancer treatments. If one or more of its new drugs pan out, the stock may, someday, look like a bargain at its present price. For now, investors are being asked to pay a high price for hope and speculation.